Monetary Growth and the Timing of Interest Rate Movements

Abstract

T IS widely believed that market interest rates follow a particular time path in response to changes in the rate of monetary growth. This time path is important because interest rates are thought to be one of the conduits of monetary policy.In particular, an unanticipated but permanent increase in the monetary growth rate will presumbly lower market interest rates, temporarily resulting in a reshuffling of resources among competing uses. As a consequence, an economy characterized by slack will be pushed to a permanently higher leẽl of aggregate demand, employment, output and, eventually, higher market interest rates as a result of the monetary stimulus.The length of the time path followed by interest rates reveals information concerning the lag in monetary policy's effect. Curiosity about this provided the initial motivation for earlier empirical investigations.' This paper discusses the theoretical argument and examines some evidence regarding the response of interest rates to changes in monetary growth. (1) i = r + PT he waxing and waning of the effects of a change in monetary growth on each of these components generates the time path followed by the nominal rate. An unanticipated change in monetary growth initially affects the cx ante real rate of interest; this is called the "liquidity effect." 2 The permanent change in monetary growth, once it is known, affects the expected rate of inflation and is called the "Fisher effect." W. W. Brown is an associate professor of economics at The Liquidity EffectThe theoretical argument concerning the liquidity effect typically runs as follows: an unanticipated increase in the monetary growth rate results initially in an excess supply in the money market at the existing nominal rate of interest. Part of this excess shows up as an increase in the demand for securities. The prices of securities are bid up, and nominal yields decline until the market clears. 3 2 Traditionally, the term "liquidity effect' was used to describe the impact of an unanticipated change in the stock ofmoney on interest rates. More recently, however, the term has been applied to the initial effect on interest rates of an unanticipated change in the stock of money induced by an unanticipated change in the monetary growth rate. We have adopted the more recent usage of the term in this paper.

The Impact of Money on Short‐term Interest Rates

“…This type of study may have been used first by Gibson [1970], Cagan [1966], and Cagan and Gandolfi [1969], and has received substantial renewed interest through the current work of Brown and Santoni [1983], Melvin [1983], and Hoehn [1983]. This type of study may have been used first by Gibson [1970], Cagan [1966], and Cagan and Gandolfi [1969], and has received substantial renewed interest through the current work of Brown and Santoni [1983], Melvin [1983], and Hoehn [1983].…”

“…The second interest rate model regresses interest rates on current and past observations of monetary growth rates to examine both direct and indirect influences of money. This type of study may have been used first by Gibson [1970], Cagan [1966], and Cagan and Gandolfi [1969], and has received substantial renewed interest through the current work of Brown and Santoni [1983], Melvin [1983], and Hoehn [1983]. The methodology does not provide a complete model of the determinants of interest rates.…”

Martingales and efficient forecasts of effective mortgage rates

“…Evidence from Brown and Santoni (1983) and Reichenstein (1987), suggesting a change in the structure of interest rates about the time of the closing of the gold window, dictated the starting date.…”

Weekly Money Announcements: New Information and Its Effects

“…This liquidity effect occurs as soon as the stock of money is increased. See Brown and Santoni (1983) for evidence about the existence, magnitude and duration of the liquidity effect.…”